Can Hungary’s central bank stay independent?

All across Europe central bankers and politicians are pointing fingers at one another over who’s to blame for high budget deficits and sluggish growth. But in Budapest the dispute has taken an omnous turn -- lawmakers are considering a measure to curb the power of the Central Bank of Hungary.

All across Europe central bankers and politicians are pointing fingers at one another over who’s to blame for high budget deficits and sluggish growth. But in Budapest the dispute has taken an omnous turn -- lawmakers are considering a measure to curb the power of the Central Bank of Hungary.

Parliamentarians from the ruling coalition parties, the Hungarian Socialists and the Alliance of Free Democrats, last month proposed amending the country’s central bank act to expand the bank’s policymaking Monetary Council from nine members to 11. The proposal would enable the prime minister to appoint a near majority of five members directly. The governor of the central bank would nominate the others, whom the prime minister would have to confirm. Currently, the governor nominates all council members, subject to the prime minister’s confirmation. The legislation also would kick two of the bank’s three deputy governors off the council.

The proposal won a quick endorsement from the government of Ferenc Gyurcsány, Hungary’s new Socialist prime minister, who stands to gain greater influence over the central bank. A former Communist youth leader who made millions in Hungarian privatizations before turning to politics in 2002, Gyurcsány was elected prime minister in September after coalition infighting over the country’s deteriorating economy forced his predecessor, Peter Medgyessy, to resign. Gyurcsány has promised to reduce Hungary’s budget deficit and keep the country on track to adopt the euro in 2010. Growth -- and the lower interest rates that spur it -- would help in this endeavor, of course.

The government insists that the proposal would merely bring Hungary into line with other European Union states, most of whose governments nominate bank officials. To the central bank and many analysts, however, the measure is a naked attempt to pack the bank’s rate-setting body and curb the power of governor Zsigmond Járai, an appointee of the previous government of the conservative Fidesz party, now in opposition.

“It’s a major attack on the

independence of the central bank,” György Szapáry, the bank’s deputy governor and head of economics and monetary strategy, tells Institutional Investor. “It’s an awful precedent when with a simple law you can take away the mandate of officials. Another government could do the same thing. Then there

is no end to it.”

The central bank’s high interest rates have made it an inviting political target. It raised its key short-term rate by 6 percentage points, to 12.5 percent, to defend the forint last year after widening budget and current-account deficits sparked a run on the currency. The forint has stabilized -- allowing the bank to ease rates down to 10.5 percent -- but the underlying deficit problem remains acute, even though local GDP growth of 3.9 percent is higher than in most of the 15 countries of the preenlargement EU. (Hungary’s growth rate is among the lowest of the eight new EU members from Eastern Europe, however.)

The central bank angered the government earlier this year by publishing its own, higher forecast of the budget deficit -- 5.3 percent of GDP, compared with the government’s 4.6 percent estimate. The government later raised its figure to 5.3 percent, but just last month the central bank warned that lagging revenues and continued high spending could push the deficit to 5.8 percent.

That deficit, and an accompanying current-account gap that is expected to hit 9 percent of GDP this year, leave Hungary dependent on the whims of foreign investors and preclude aggressive rate cuts, Szapáry says. Any rate cuts “have to be justified by improvements in the fundamentals,” he adds.

Most investors side with the central bank in this dispute. Jerome Booth, head of research at Ashmore Investment Management, which manages $6.5 billion in emerging-markets bonds, calls the legislative initiative “a backward move. Having a go at the central bank is hardly helpful for the credibility of fiscal policy.”

Szapáry is unlikely to be intimidated by legislative threats. In 1956, as a teenager, he fled Hungary with his family to escape the Soviet invasion. He earned a Ph.D. in economics at the Catholic University of Louvain in Belgium, worked briefly at the European Commission in Brussels and then spent 24 years at the International Monetary Fund in Washington before returning to Budapest in 1990.

Szapáry and his central bank colleagues are actively lobbying the EU for support, and may well succeed. As an EU member, Hungary must submit the proposed changes to the European Central Bank. The ECB, which is to deliver its opinion this month, warned in an October report that Hungary and most other new EU members were moving too slowly to bring their deficits below the 3-percent-of-GDP ceiling for adopting the euro. When asked at a news conference about the Hungarian proposal, ECB president Jean-Claude Trichet, a notable deficit hawk, simply said he was satisfied with Hungary’s existing bank statute. A compromise that gives the Hungarian government more sway over the council without stripping the central bank of its independence is considered the most likely outcome.

For Szapáry, Hungary’s key objective right now should be deficit reduction, so it can adopt the euro in 2010. “It’s doable,” he says. “We are much closer than many of the current members were five years prior to joining the monetary union.”

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